Zapping the Fun out of Tax Fraud

Sep 07, 2018

How your state can save a billion dollars

For many states, sales tax makes up about one-third of state revenue dollars. These dollars are a crucial component for states to offer vital services including education, healthcare, parks and recreation, and much more. But as hard working Americans pay their taxes in order to fund these programs, sales suppression methods and software are threatening to steal these dollars away. This loss of revenue is harmful to the provision of essential services. To give you a sense of how much these devices are costing the states, a Bloomberg article stated that, "revenue loss for the states from sales suppression, in the restaurant industry alone, is at $21 billion annually." To curtail this fraud, states are enacting legislation with penalties and even prison sentences for fraudsters convicted of this crime.

More than half of the states have enacted legislation that criminalize the use of sales suppression devices, and now Arizona joins the pack with the successful passage of SB 1386. Arizona technically does not have sales tax, but it does have a transaction privilege tax (TPT) which places the burden on sellers to collect the 5.6 percent state levy on all sales and remit it back the state. In April, Arizona lawmakers passed SB 1386 which makes it a Class 5 felony to purchase, install, or use any “automated sales suppression device or service’’ with the intent of cheating the state. Those found guilty could face not only having to repay what they owe, with interest and penalties, but also fines of up to $100,000 — and $500,000 for corporate offenders. In addition to the fines, the offense carries a presumptive sentence of 18 months in state prison for a first offense.

The law may help deter some fraudsters, but prosecution is a time consuming and expensive process for states and it won't be possible to bring every case to criminal proceedings. Although there needs to be a legal consequence,states also need methods and tools to provide stronger enforcement; they need data analytics. Keep in mind that a zapper is not necessary to suppress sales, since the good old fashion hitting the “no sale” button works great, so analytic tools are needed to provide a more proactive response by identifying someone who is likely to suppress their sales – no matter the method or software used.

Sales suppression detection is a two-step analytical process.The first step is audit selection which involves the use of predictive models to select businesses that have indicators of sales suppression based on many dimensions. One indicator is derived from the distribution of cash vs non-cash transactions over time. A machine learning algorithm can then identify statistically significant deviations from the distributions of similar businesses. Once a business is selected for audit, the second step involves POS data analytics which then uses models to determine the likelihood of zapper technology being used in tax evasion.

There are many methods to determine if zapper technology is being used. For example, an algorithm can search for missing transaction ID numbers in the POS data, indicating the potential presence of zappers. You could also compare the distribution of cash vs non-cash transactions for a given year against other years of POS data. Statistically significant changes in this metric year-over-year could indicate potential non-compliance. Regardless of the methods used, this two-step process will lead to increased auditor efficiency and accuracy. However, using analytics requires more than one dimension for selection. Using several techniques, like cluster analysis, decision trees, and regression creates an “ensemble” approach, which we have seen demonstrable improvements for audit selection over business rules.

Identification of sales suppression should take a higher priority over whether a tax zapper is on a machine to prevent the loss of much needed revenue.With data analytics, states can recover revenue more rapidly and boost long-term compliance. Sales suppression may seem like a victimless crime, but the lost revenue has real consequences.